Hotter-than-anticipated inflation figures on Friday widened the gap between where many policymakers had hoped price pressures were heading and the path suggested by fresh data, setting the stage for what economists increasingly view as a likely interest-rate increase by the Federal Reserve next week.
The Bureau of Labor Statistics reported that core consumer prices - excluding food and energy - rose 0.3% in August from July, outpacing the 0.2% month-over-month increase economists had expected. On an annual basis, core CPI increased 2.4%, while headline consumer inflation stood at 3.4% year-over-year.
Those readings arrived alongside a stronger-than-expected August producer price index released on Thursday and a sharp rise in oil prices, which have climbed above $100 a barrel amid renewed hostilities in the Middle East. Taken together, the signals point to upside pressure on inflation measures the Fed watches most closely, and contrast with the cooling trend some policymakers had hoped was taking hold over the summer.
Policy implications
Nationwide Chief Economist Kathy Bostjancic framed the renewed increase in energy costs as a transmission risk: "The renewed march higher in oil, gasoline and diesel prices add to concerns that higher energy prices could spill over to other goods and services and inflation expectations," she wrote. Based on the latest figures, Bostjancic said she now expects the Fed to raise rates by 25 basis points at next week’s policy meeting.
The Federal Reserve has kept its policy rate in a 3.50%-3.75% range throughout this year. Last month Fed Chairman Kevin Warsh signaled the central bank could act if he lacked confidence that underlying inflation was moving to the Fed’s 2% target "clearly and at sufficient speed." Economists writing on Friday said the August data appears not to meet that standard and will likely reinforce concern among officials who had viewed June and July’s cooling as potentially durable.
Seema Shah, chief global strategist at Principal Asset Management, emphasized how the combination of August’s core CPI print, the spike in energy costs and persistent geopolitical tensions has shifted the policy outlook: "Today’s clean 0.3% core CPI print, combined with the sharp rise in energy prices and persistent tensions with Iran, all but locks in a Fed rate hike next week," she wrote. Shah added that after half a decade of inflation above target, policymakers may conclude that more than one hike will be necessary to restore price stability.
Market response and nuance in the data
Short-term interest-rate futures traders have moved to price in the policy shift: the probability of a quarter-point increase at the Fed’s September 15-16 meeting rose to about 85% after the report, up from roughly 70% before the data release. That repricing itself creates an additional incentive for the Fed to deliver a hike and avoid surprising market participants.
Analysts note, however, that part of the August core CPI rise was concentrated in a single component. Wireless services jumped 5.9% in the month, a significant outlier that inflated the overall core reading. "To be sure, the core rate would have been far more modest without this extraordinary rise," wrote Omair Sharif of Inflation Insights. He added a caveat about the Fed’s decision calculus: "That said, I am not sure the Fed can play that game right now with odds of a hike pushing to the 90%-ish zone."
Outlook
The combination of the CPI report, the firm PPI data and rising oil prices has shifted near-term expectations toward tighter policy. With markets now assigning a high probability to a 25-basis-point move, the Fed faces pressure to act in line with market pricing and the recent data. How the committee interprets the durability of the wireless-services increase, the pass-through from energy into broader inflation, and whether further hikes will be needed remains central to the coming discussion among policymakers.